Hello, everyone, and welcome to the Southwest Airlines Fourth Quarter 2023 Conference Call. My name is Gary, and I will be moderating today's call. This call is being recorded, and a replay will be available on southwest.com in the Investor Relations section. After today's prepared remarks, there will be an opportunity to ask questions. At this time, I'd like to turn the call over to Ms. Julia Landrum, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you so much. And welcome everyone to Southwest Airlines Fourth Quarter 2023 Conference Call. In just a moment, we will share our prepared remarks after which, we'll be happy to take your questions. On the call with me today, we have our President and CEO, Bob Jordan, Executive Vice President and CFO, Tammy Romo; Executive Vice President and Chief Commercial Officer, Ryan Green; and Chief Operating Officer, Andrew Watterson. A quick reminder that we will make forward-looking statements, which are based on our current expectations of future performance, and our actual results could differ materially from expectations. Also, we will reference our non-GAAP results, which exclude special items that are called out and reconciled to GAAP results in our press release. So please refer to the disclosures in our press release from this morning and visit our Investor Relations website for more information. With that, I'm pleased to turn the call over to you, Bob.

Thank you, Julia, and thank you, everyone, for joining the call today. As we close the books on 2023, I want to take a moment to reflect on how far we've come. And more importantly, I want to thank the people at Southwest Airlines for their dedication, their warrior spirit, their heart, and ultimately, for their incredible resilience. At this time last year, we were getting back on our feet from the disruption following Winter Storm Elliott. We quickly mobilized to put immediate mitigation efforts in place while simultaneously building a robust plan to prepare us for future extreme winter weather disruptions. We are also working to restore our network, address our staffing needs, and return our aircraft to full utilization. And of course, we were in the middle of negotiations with the majority of our labor unions. I'm incredibly pleased to be on the other side of 2023 and to be able to share all the progress we made last year. We completed a comprehensive winter weather action plan, which has already been successfully tested in multiple winter weather events, including the extended nationwide winter storms we experienced this month but also with other types of disruptions such as hurricanes, severe fall in Chicago, and the Maui fires. Through all of those events, our aircraft and crew networks remain stable. We recovered quickly, and we were able to minimize the impact on our customers. We also got fully staffed, restored our network, and reached the full utilization of our fleet. Our network is in a healthy place, and it shows in our operational improvement. In fact, we improved in nearly every operational metric. Our completion factor performance, in particular, was fantastic at 99% for the full year, with the fourth quarter being our best quarterly performance in more than a decade at 99.6%. We also made significant progress on our labor agreements, including ratification earlier this week of an agreement that secures industry-leading pay for our best-in-class pilots. We have now successfully reached ratification on nine contracts in a little over a year, demonstrating our commitment to providing competitive market compensation packages for our people. This is a huge accomplishment, and I would like to thank all those who have tirelessly supported those negotiations. Of course, all this was in addition to a host of other accomplishments: the rollout of a new revenue management system, the launch of multiple customer experience improvements, and the negotiation of a very cost-effective order book with Boeing. The order book allows us to continue the modernization of our fleet and provides the opportunity to flex our growth plans up or down over the long term. We also made rapid adjustments to capacity for both 2023 and 2024 and put in place significant network adjustments in response to changing demand patterns. These changes reduced our planned 2024 year-over-year capacity increase to roughly 6%, all of which is carry-over from 2023 network restoration. So there will be no net new additional capacity in 2024 as we work to mature our route network. Moving to our performance, we continue to be very pleased with the core demand for our product. We saw close-in performance strength in November and December for both leisure and corporate travel. This led fourth quarter 2023 to be yet another record at just over $6.8 billion in operating revenue. And we are seeing that strength continue into 2024. This demand strength, combined with about $1.5 billion in incremental year-over-year pre-tax profit from our network optimization efforts and contributions from our portfolio of strategic initiatives, is driving us to expect additional revenue records and year-over-year operating margin expansion despite cost pressures from new labor agreements and increased aircraft maintenance expense. Our network changes are materially in place with the March schedule, where we expect to hit a profitability inflection point. While still early in the quarter, our initiatives are delivering towards our revenue target, and we expect to exit the quarter with a strong operating margin for the month of March. While we have significant inflationary pressures from our new labor agreements, we have initiatives underway that will begin to help counter these pressures with efficiency improvements. These include everything from scheduling techniques to digital modernization, and we planned in 2024 with headcount flat to down as compared with year-end 2023 as we slow hiring to levels that are at or below our attrition rate that will drive efficiency gains in 2024 with more to come in 2025. All of this supports a solid plan with a line of sight to improve our financial returns and earn our cost of capital in 2024. While this represents notable progress, I want to be clear: earning adequate and consistent returns, ROIC well in excess of WACC is our financial North Star, and it's not negotiable. We will be relentless in executing against our plans, and we will continue to make adjustments, including capacity adjustments, if needed, until we deliver those results. Adequate and consistent return is how we have created decades of shareholder value, and it continues to be our key focus. Our current set of initiatives is tracking nicely, and we'll provide you a lot more detail later this year at Investor Day. In addition, we're working on a next seven initiatives to support in support of sustainable returns over time. In closing, we made tremendous progress in 2023, and we finished the year a much stronger company. We will finish this year stronger again. We are fully committed to improving the customer experience and delivering on our long-term financial targets, including generating returns for our shareholders. As always, I have confidence in our people and our business model, and I am particularly proud of our people for their dedication and their resilience. They remain our absolute greatest asset, the heart and soul of our company and the ultimate source of pride for me. And with that, I will turn it over to Tammy.

Thank you, Bob, and hello, everyone. As Bob mentioned, 2023 wasn't without challenges, but we are stronger and ready to take on another year, and that is all thanks to our incredible employees. We delivered $996 million in profits for the year and our fourth quarter net income of $233 million, both when excluding special items, was on the better side of our expectations. We prioritized the restoration of our network and operational reliability in 2023, which has taken a lot of resources and focus. With our operations now stable and the network fully restored, we can drive much more focus and energy to consistently delivering a strong financial performance, along with delivering operational excellence. We have incredible strengths to build upon and the levers we need to optimize and regain our position as an industry leader. We will be steadfast in our efforts to make meaningful progress this year in support of our long-term goal of generating consistent returns well in excess of our cost of capital. Ryan and Andrew will cover the headway we've made with our revenue and operations performance in detail. So, I'll start with our cost performance before moving to fleet and balance sheet. Overall, our unit cost excluding special items were down 16% year-over-year in the fourth quarter. Our fourth quarter average fuel price of $3 per gallon was right at the low end of guidance, primarily due to jet fuel prices in the L.A. market steady after significantly spiking in mid-November. Thankfully, market prices dropped as we moved into this year, and our fuel price guidance of $2.70 to $2.80 per gallon for the first quarter and $2.55 to $2.65 per gallon for the full year and the welcome reduction in fuel costs compared with 2023. We are currently 60% hedged here in the first quarter and 57% hedged for the full year, with more meaningful hedge protection kicking in at Brent prices around $90 per barrel. That's a higher strike price than where our 2023 hedges began to provide meaningful protection, which was closer to $70 per barrel. This is reflective of the current market conditions and the elevated cost of hedging. We continue to prudently add to our fuel hedge position for 2026, nearing 20% hedged and currently 46% hedged in 2025 in line with our goal to be roughly 50% hedged in each calendar year. While we are not fully immune to the volatile energy market, I am grateful that our hedging positions provide meaningful protection against catastrophic increases while also allowing us to participate fully when market prices decline. Moving to non-fuel cost, our fourth quarter year-over-year CASM-X decrease of 18.1% was on the favorable side of our guidance range, driven primarily by elevated operating expenses and lower capacity levels in the fourth quarter of 2022 as a result of the operational disruption. This was partially offset by general inflationary cost pressures, including higher labor rates for all employee work groups, as well as elevated maintenance expense. Both of which are sticky as we move into 2024. I also want to congratulate our pilots on their newly ratified contract. Obviously, the market for pilot wages has increased significantly, and it is important that we keep pace to reward our employees appropriately. As a result of the new agreement, we recorded a change in estimate for the pilot ratification bonus, and you can find the details and breakout of the accounting treatment in this morning's press release. Looking to the first quarter of 2024, we currently estimate our CASM-X to increase in the range of 6% to 7% year-over-year, with roughly 3 to 4 points of this estimated increase driven by higher overall 2024 labor costs and market wage rate accruals. The remainder of the first quarter CASM-X increase is primarily due to year-over-year pressure in maintenance expense, driven by rate increases as well as an increase in maintenance activity as our 800s are coming off their honeymoon period. Speaking to full year cost, our CASM-X guidance of a 6% to 7% increase year-over-year is also essentially driven by labor and maintenance cost pressures. Roughly 4 to 5 points are attributable to labor and roughly 2 points are from maintenance for the reasons I previously covered. While we accrue for market wage rates, the recently ratified pilot contract contributes the majority of the labor CASM-X increase this year due to a step-up in wage rates, work rule changes, and enhanced benefits. As Bob mentioned, we are steadfastly focused on regaining efficiencies to help counter some of the structural cost pressures as we look to control what's controllable. We are not satisfied with our current financial performance, and we will work relentlessly until we produce the financial strength and returns you should expect from Southwest Airlines. We have a solid 2024 plan, which includes the benefit of roughly $1.5 billion in incremental year-over-year pre-tax profits from our strategic initiatives. The vast majority of the initiatives delivering value in 2024 are revenue related, contributing well over $1 billion of the $1.5 billion total expected incremental benefit. And our network optimization and market maturation efforts are providing the bulk of that revenue lift. The balance of the revenue-generating benefits come from incremental managed business initiatives, primarily increased GDS participation. The incremental cost benefit relates primarily to fleet monetization and early yields from other operating efficiency efforts such as digital service modernization and our turn initiative. We will go into a lot more detail on our initiative portfolio at Investor Day later this year. While early, our plan provides significant progress towards our long-term goal to generate ROIC well in excess of our cost of capital. Again, more details to come at our 2024 Investor Day. Now turning to our fleet. During 2023, we received a total of 86-8 deliveries, more than planned, and retired 39-700 less than planned, ending the year with a total of 817 aircraft. We consistently mentioned the flexibility in our fleet modernization efforts being a key competitive advantage, and the minor shifting of deliveries and retirements throughout 2023 validates our ability to thoughtfully plan and execute given the continued supply chain challenges facing Boeing. Moving into 2024, there is continued uncertainty around the timing of expected Boeing deliveries and the certification of the MAX 7 aircraft. Our fleet plans remain nimble and currently differ from our contractual order book with Boeing. We are planning for 79 aircraft deliveries this year and expect to retire roughly 45-700 and 4-800, resulting in a net expected increase of 30 aircraft this year. Taking our current plan into consideration, we expect our 2024 CapEx to be in the range of $3.5 billion to $4 billion. After finalizing our 2024 plans and refining capacity levels to better reflect the current environment, we now expect full year 2024 capacity to be up about 6% year-over-year. Our 2024 capacity plans do not currently include any MAX 7 flying. So, certification of that aircraft continues to push out our 2024 capacity plans will not be impacted. In addition, we are also reducing our total fuel expense with our fleet modernization initiatives as we continue to bring on more fuel-efficient -8 aircraft and retire -700. We saw a nearly 3% year-over-year improvement in fuel efficiency in 2023 and expect continued improvement this year. In addition to fuel savings, our fleet modernization initiative is a key component in reaching our environmental sustainability goals. Lastly, I am proud to report that our balance sheet strength continues to be a financial backbone as we move into another year. We remain the only US airline with an investment-grade rating by all three rating agencies. We ended the year with $11.5 billion in cash and short-term investments, returned $428 million to our shareholders through dividend payments in 2023, paid $85 million to retire debt and finance lease obligations in 2023, and continue to be in a net cash position. We expect to pay a modest $29 million in debt payments this year and continue to expect interest income to well exceed our expected interest expense of $249 million in 2024. So, we are pleased to have a plan for significant financial improvement to be made this year. With some major milestones behind us, such as restoring our network, becoming fully staffed, fully utilizing our fleet and so much more, our sights are set on expanding margins and covering our cost of capital in 2024. And as I close, I'd like to sincerely thank our people for another year of hard work and dedication to the mission and vision of Southwest Airlines. I am so grateful for each and every one of you. You were truly my heroes. And with that, I will turn it over to Ryan.

Thank you, Tammy, and hello everyone. Let me start by sharing that I am very pleased with the overall demand for our business, the execution from our amazing people, and the engagement of our loyal customers. Fourth quarter unit revenue finished slightly better than expectations at down 8.9% year-over-year. The improvement was driven by a strengthening of close-in revenue performance in November and December for both leisure and corporate business travel, as well as the continuation of overall strong holiday performance and market share gains from our managed business initiatives. I'm pleased to report that we saw no bookings impact from last year's operational disruption during this past holiday season, which speaks to the operational improvements we have made over the last year, as well as the enduring loyalty from our customers. In addition, the fourth quarter was another quarter with multiple records set, including record fourth quarter operating revenue and passenger revenue, as well as an all-time quarterly record for passengers carried. Fares also performed well in the fourth quarter, with our average passenger fare up about 2.5% year-over-year. All in all, our fourth quarter operating revenues were up over $1 billion relative to the fourth quarter of 2019. And while we still have work to do on our revenue performance, I remain very pleased with our progress. Looking to our full-year results, we grew 2023 operating revenues nearly 10% year-over-year to a record $26 billion, accompanied by record passengers, record Rapid Rewards revenue, and record ancillary revenue. And speaking of records, we set operating revenue records in each quarter of the year and for the full year of 2023. As we move into 2024, we are seeing the momentum continue, and we're seeing early but highly encouraging benefits from our network optimization efforts, and we expect first quarter unit revenue growth of 2.5% to 4.5% when compared to the same period last year. This represents a solid sequential improvement in year-over-year unit revenue performance even when normalized for the five-point tailwind from the prior year disruption impact. In fact, our guidance would imply first quarter 2024 nominal RASM to be about five points higher than our normal seasonal sequential average when compared with nominal fourth quarter of 2023 RASM. We currently have about 60% of expected bookings for first quarter already in place, slightly above normal, and we are seeing better than normal sequential RASM performance, further demonstrating that our network optimization efforts are working. As we refined our capacity plans for this year, we've been able to pull in even more flying out of the shoulder periods, which we believe will be a tangible contributor to boosting our performance. While our forecast doesn't assume any material increase in demand for domestic air travel in 2024, we do have a line of sight to double-digit operating revenue growth year-over-year, driven largely by the network and initiative-driven revenue that Tammy detailed. Included in that, of course, are our efforts to drive managed business. We are very pleased with the performance of our managed business initiatives and the success of our Southwest business team. In the past year, we had a solid increase in market share, more than three points in the managed business space, and I'm very proud we improved our Business Travel News ranking from fourth place in the industry in 2019 to second place in 2023. We were the only carrier in the survey to receive an increased total score two years in a row while each of our competitors' scores have declined over that same period. It's another example of the progress we're making against the industry in the managed business space. Of course, we're also continuing our efforts to improve our customer experience and our Rapid Rewards program. We are seeing improved customer satisfaction scores with our Wi-Fi product as we proceed with our infrastructure investments there and more aircraft are joining the fleet every day with Wi-Fi power and larger bins on board. We've made several enhancements to our award-winning Rapid Rewards program, including making it easier to reach our A-List and A-List Preferred levels, and we will soon be rolling out the ability to book travel with a combination of cash plus Rapid Reward points later this spring. We introduced customer bag tracking to reduce friction in our customers' travel experience, and we look forward to sharing more on our larger digital hospitality modernization plan in the coming months. All of this is designed to make it easier to fly with us and give customers even more reasons to choose Southwest. As we enter 2024, we have a very solid plan that leverages the unparalleled strength of our people, our product, our loyalty program, and our route network, and we look forward to delivering on continued progress towards our long-term financial goals. With that, Andrew, over to you.

Thank you, Ryan, and hello, everyone. I'd like to start out by recognizing our people for their efforts in successfully managing through four different named winter storms that spread over 11 days and impacted a wide portion of our route network with intense weather conditions and frigid temperatures this month. These overlapping winter systems definitely put our winter operations fairness plan to the test. Overall, I'm very pleased with how well we managed the storms. The sheer magnitude of these weather systems resulted in significant cancellations, the vast majority of which were proactive on our part. Our cancellations were made 14 hours in advance on average, and 70% were canceled with at least six hours in advance. As you can imagine, providing that much notice improves the customer experience. In fact, we have found that it can result in MPS scores that approximate those with customers with no disruption to their itinerary. Overall cancellation rates were in line with the industry and were primarily isolated to the operations directly impacted by the storms, with fewer than 2% of our cancellations tied to crew scheduling challenges. This is a significant contrast to what we experienced with winter storm Elliott in December 2022. The improvement is a direct result of last year's winter operations investments and protocols. I echo Bob's sentiments that we are in a much better spot today than a year ago. In the past year, we not only completed the winter operations preparedness plan, we also delivered on a long list of initiatives to modernize our operation with benefits for both our customers and our employees. Our people have the staffing, equipment, tools, and infrastructure to operate safely and at pace in winter weather. The good news is that all the hard work showed up in our operating performance. We closed out 2023 with only about 1% of our total flights canceled, and we improved in basically every metric. Our completion factor, on-time performance, early morning originators, turn compliance, and turn differential as well as mishandled baggage, all showed substantial year-over-year improvement, which in turn led to a year-over-year improvement in our Trip Net Promoter Score. As we enter 2024, we will focus on continuing to build on our 2023 priority of operating quality. We ranked fourth place in the 2023 Wall Street Journal Airline Quality Metrics despite several metrics covering the winter storm Elliott period. Our goal is to move up this ranking and ultimately be ranked number one. We will also double down on three additional priorities: bringing out operating inefficiencies, increasing asset productivity, and creating operating leverage by reducing structural costs. These are multiyear initiative-based efforts, which will begin yielding material benefits in 2025. We'll share more on these in the coming months. Finally, I'd like to close by congratulating our pilots on our new contract. I'd also like to thank all the negotiating teams who have worked so hard to reach nine agreements since October of 2022. These teams worked tirelessly, and I am pleased we can reward employees with well-deserved pay increases and quality of life enhancements. We remain in negotiations with two union represented groups, TW555 and TW556, and we look forward to reaching agreements to reward those employees for their contributions. So with that, I'll turn it back over to Julia.

Thank you, Andrew. This completes our prepared remarks. We will now open the line for analyst questions. We would like to speak with as many of you as possible, so we ask that you limit yourself to one question and a brief follow-up if necessary. Please go ahead with the first question.

We will now begin the question-and-answer session. The first question comes from Ravi Shanker with Morgan Stanley. Please go ahead.

Thanks. Good afternoon, everyone. Maybe we can start with the $1.5 billion kind of initiatives. And any chance you can share more detail there, kind of details on what the different contributing items are, and also how much visibility do you have into that? Trying to get a sense of how much of that may be in the bag, so to speak?

Hey, Ravi, it's Bob. I'll begin, and then Ryan may want to chime in. A significant part of the year-over-year improvement relies on the initiatives being effective, and I am quite confident about that. Some of this stems from our ongoing Investor Day initiatives performing well. Additionally, we have new projects, primarily the network improvements, which started significantly in March and will be fully implemented by early summer. We have strong confidence in the Investor Day initiatives delivering results. Although it’s still early in the quarter, we have some insight into how March is shaping up with the network changes and optimizations, and we’re on target there. We are adjusting to new demand patterns, such as those related to Tuesday and Wednesday travel. I believe we are on course to achieve that incremental $1.5 billion, with most of it being revenue, approximately two-thirds related to revenue. Ryan, do you want to add anything?

Yes. A significant portion of our revenue initiatives is driven by network optimization and the ongoing development of our markets. By the end of 2024, the mix from these development markets is expected to stabilize within normal ranges, which will be beneficial. We've been observing the maturation of these development markets over the past few years. Additionally, the other revenue initiatives in place will continue to develop and offer further advantages as the airline expands. A major part of this comes from the managed business initiatives we've discussed, and I am very optimistic about their ongoing performance. Managed business showed improvement in the fourth quarter compared to the third quarter, and we anticipate further gains in the first quarter. We are seeing this reflected in our January bookings as we approach the February booking period. Overall, the results from the fourth quarter, along with our outlook for the first quarter and beyond, make me very confident.

Very helpful. And maybe as a quick follow-up. I'd love to get your thoughts on the apparent premiumization of the domestic product. Obviously, you guys are committed to a single cabin, but does that give you kind of more room to raise RASM across the product or kind of just what your response to that be?

Well, premium certainly is a hot topic in the industry, and it's something that we watch closely. We also talk to our customers on a regular basis. This is one of the things that we continue to get their feedback on. And I think we talked about it some on the last call. As you think about premium, historically in the industry, premium revenue has been highly cyclical. This is one of those times where carriers are adding premium seats into the cabin. But when the economic cycle shifts, they're pulling seats, premium seats out of the cabin. And so, as we see kind of the recovery here from the pandemic, we'll have to see how these trends persist and go forward. I think overall RASM, obviously, we follow that and how we compare relative to the industry, and we're working on improving that as we go forward here. I will say that ancillary revenue, the majority of which is boarding products, our early bird product, as well as our upgraded boarding product is doing very well. We're having record ancillary revenue performance. And so I think, yes, we have a single cabin, but we're able to improve RASM and grow ancillary revenue through some of those boarding products as well.

Very helpful. Thank you.

The next question is from Jamie Baker with JPMorgan. Please go ahead.

Good morning everyone. I want to start a conversation about domestic capacity; I'm still on that topic, right?

You're there.

Yes. Sorry about that. It was probably the tamest expletive that I've ever said. Lots of discussion about domestic capacity cuts, your own and others. Just curious, though, in markets where you overlap with lower-cost competitors, have you seen any changes in how they're competing other than just the capacity cuts? I mean, there's been speculation of lower OA pricing as some of those airlines try to regain profitability. I'm not seeing any of that, but it's that sort of thing that I'm asking you about.

Yes, Jamie, there are numerous moving parts at the moment. As Ryan mentioned, certain areas of the cabin are performing better than our route network. We're seeing a lot of capacity shifting within the industry, along with mergers, which makes it difficult to assess the situation. Additionally, capacity is affected by aircraft deliveries and other issues. I believe all these factors are likely to worsen throughout the year, and their impact on capacity and aircraft will continue to grow, especially with potential issues from Boeing and geared turbofans. We will have more updates on our side. We are concentrating on Southwest Airlines, and I am very pleased with what we achieved in 2023. We have become a significantly better carrier compared to the previous year. However, I am not satisfied with our financial performance, as we are currently operating about four points below our cost of capital. This is our primary focus at Southwest, and we have a solid plan in place for 2024.

Pardon me. This is a conference operator. We seem to have lost connection with the speakers' location. Please stand by while we try to rejoin. Pardon me, this is a conference operator. We regained the audio from the speaker's location. Please continue.

Jamie, my apologies there. I don't know where we left off. But my point is we are focused on Southwest. We're focused in 24 years on expanding margins and covering our cost of capital that sets us up for a lot of momentum to then even make even more progress in 2025. And thinking about capacity for Southwest Airlines, our capacity, our CapEx, as we plan forward, will obviously take into consideration the progress we are making against those financial goals. I just want you to know that.

Okay, that's helpful. You've mentioned before that you seriously considered having a second fleet type but ultimately chose not to pursue that option. Given the increasing industry contention towards your sole provider, would it be unreasonable to think that your commitment to a single fleet might start to diminish, or am I misinterpreting your position?

Yes. Let me take a moment to elaborate. There’s a lot happening with Boeing. The MAX 8 is an excellent aircraft, and we are very pleased with it. We support the FAA's efforts to enhance quality and resolve any concerns because improving Boeing benefits Southwest Airlines. We regularly evaluate aircraft manufacturers and types as part of our routine at Southwest Airlines. Currently, we are focused on our fleet plan, specifically our partnership with Boeing and getting the MAX 7 certified. It’s essential to understand that there is no way to completely eliminate risk in this area. Even if we had multiple aircraft providers, having half our fleet in one type and half in another still poses significant risk if issues arise. Therefore, our best approach is to collaborate with Boeing to help them improve, and that process is already underway. We remain confident in the MAX 8 and look forward to the MAX 7. While we are not responsible for the certification timeline, we believe Boeing will resolve these matters and emerge stronger with the FAA's support.

Appreciate the color. Take care, everyone.

The next question is from Catherine O'Brien with Goldman Sachs. Please go ahead.

Hey, good morning, everyone. Thanks so much for the time. Maybe just a couple of quick ones. On unit revenue going forward, underlying your double-digit top line forecast for the year. Can you just help us think about where we go from the 1Q unit revenue forecast? I'm assuming based on the full year capacity outlook growth is going to slow from the first quarter into the remaining quarters of the year. So that would be a sequential tailwind. You'll be lapping some of that easy comp from the book away as we move through the year. How does that impact where you think unit revenue trends quarter-to-quarter? Anything else lumpy we should be considering?

Yes. I'll begin, and then Ryan can add any thoughts he has. As you mentioned, there is some noise in the year-over-year comparison. The best way to approach this is sequentially. The first quarter is typically a challenging period for the airline industry. Our network changes will significantly take effect in March, and by the summer, we anticipate completing our summer schedules. Throughout the year, we expect our development markets to continue maturing, with 10% of our system currently in development markets. By year-end, we aim to align that closer to our historical level of around 5%. Additionally, as Ryan indicated, we believe our managed business revenue will keep growing. With our GDS initiative, we expect to see those benefits steadily improve as the year progresses. We have a lot of momentum heading into this year and expect that to continue.

Pardon me. This is a conference operator. We've again lost audio from the speaker location. Please standby as we try to regain it. Thank you. This is the conference operator. We've regained audio from the speaker's location. Please continue. Thank you.

I apologize for the technical difficulties we're experiencing. To expand on what Tammy mentioned, we are witnessing a decrease in capacity throughout the year: 10% in the first quarter, 8% to 10% in the second quarter, and 3% to 5% in the third quarter. The second half of the year is still uncertain. We've seen declines in trips and seat availability. However, our initiatives, especially those related to network revenue and market development, have accelerated since they began in March. So, while we are experiencing reduced capacity this year, we also expect an increased contribution from our network initiatives as the year progresses. That's my perspective on the matter.

I wouldn't add much else, except to mention that the revenue initiatives are not very variable and are fairly consistent throughout the year. The main concern is the decreasing capacity in the latter half of the year along with the efforts to mature and optimize the network.

Makes a lot of sense. And then maybe just for my second question. Would just like to talk about the unit cost side for this year, and I know very early, but maybe first 2025. Can you talk to us just about like some of the incremental headwinds you're expecting for 2024 versus what you were thinking back earlier in 2023 when you're targeting unit costs to be down year-over-year, of course, at least a couple of points that lower capacity. The pilot contract came in higher. It would be great if you could just walk us from that, down year-over-year to up $6 million to $7 million. And then, again, early, but into 2025, if we lap the big step-up in wages or back to something more inflationary plus, I'm guessing you're going to get more efficiency back as you go into year two of the network recovery in your optimization phase, like is that when we get the down year-over-year? Any color there would be great. Thanks so much for the time.

Thank you. I’ll begin, and then I'm sure Tammy will contribute. We have accounted for our labor contract increases. We have completed nine contracts and have two remaining. Most of the increases for 2024 are related to rate increases. For instance, pilots will receive a 4% rate increase and there are some benefit increases as well. This accounts for the majority of the $6 million to $7 million. Additionally, we are experiencing known maintenance pressures, particularly with the 800 engines coming off holiday, which contributes a couple of points. Wage rate and maintenance pressures are challenges that many in the industry face. Regarding efficiency, we have reached our peak hiring and our target is to finish 2024 with a smaller workforce compared to the end of 2023, which will naturally enhance our efficiency amid 7% growth. It is too early to discuss 2025, but if you consider a forecast, it is likely we will see a deceleration in unit cost pressures compared to this year. While we are not prepared to share specific numbers for 2025 at this point, our goal will be to significantly manage headcount growth again in that year. We will provide more details during our Investor Day later this year. Tammy, would you like to add anything?

You covered everything. The situation is quite straightforward: labor costs and rates have risen more than we expected. With the pilot contract finalized, we've made adjustments to our accruals. Most of 2024 will reflect the increases in scale, wage rates, and enhanced benefits. Bob discussed the maintenance aspect, and we'll provide more details at Investor Day, but we are concentrating on improving our efficiencies as we progress through 2024 and into 2025.

The next question is from Duane Pfennigwerth with Evercore ISI. Please go ahead.

Hey, thanks. Appreciate the time. So, maybe just one more shot at this. Can you give us your best guess as to the contributors to the sequential improvement here? How much of that five points would you attribute to these network realignment initiatives? And how much would you attribute to just better underlying demand? It's been challenging with airlines to really make a read about the macro based on what airlines are doing in any given quarter. Just like in the third quarter of last year, I didn't think that was a particularly good read on the macro. But if you just look at this revenue outlook here, what is your business telling you about the macro? And are you seeing acceleration and if so, where?

Yeah, Duane, it's Ryan. I think the overall demand in the macro environment is very robust. We closed the fourth quarter with a notable improvement in performance during the holiday season, exceeding our expectations at that time. This was a positive indicator as we entered the year. As we begin the first quarter, we have about 60% of our bookings secured, which gives us a solid basis to assess macro trends. Demand appears to be very strong in January and February, which are usually slower months for us. We're doing well. Looking ahead to March, both spring break and Easter travel are looking promising. Additionally, when we consider the managed business trends, fourth quarter performance was better than the third quarter, and we expect the first quarter to surpass the fourth. We have strong bookings for managed business in February as we start to engage that segment. Overall, the macro environment is shaping up favorably for us to have a successful year.

Just a follow-up there. Any focus cities or parts of the country that are kind of waking back up for you?

Destination-based markets are performing well. International markets are thriving. In Hawaii, we exceeded our expectations in the fourth quarter. Markets like Phoenix, Orlando, and Vegas are also doing very well for us. California has been slower to recover, but it is definitely showing improvement. There are positive trends across different areas. Overall, things continue to get better.

Okay. Thank you.

The next question is from Brandon Oglenski with Barclays. Please go ahead.

Hey, good afternoon, and thanks for taking my question. So can I come back, I think, to the first Q&A here, which was about the premiumization of the industry. Because I think what we did observe through 2023 was some growing yield differential between yourself and maybe some low-cost competitors relative to the network airlines. And I guess I just want to ask the question maybe more bluntly or directly. Does product matter and does it matter as you go further in distance and longer in flight length? And I guess I'd specifically ask about your experience in Hawaii as well. And I guess how do these initiatives that you guys are talking about on the commercial side start to try to address that? Thank you.

First of all, I definitely believe that product is important. From my perspective, Southwest Airlines offers the best coach product in the industry. I also want to emphasize that the premium aspect of our service is highly cyclical, and before addressing that further, we need to analyze it closely. Regarding our performance in the long-haul market, specifically in Hawaii, we exceeded our own expectations in the fourth quarter. Our yields are improving, and we will continue to develop those yields further. Overall, our product performs well even in long-haul markets. It's clear that product quality matters, and currently, there seems to be less demand for lower-end products in the industry compared to what we have seen in the past.

And Brandon, this is Bob. The only thing I would add is that this is not a prediction; don't read into this too much. You need to meet your customers' demand and their expectations. As those change over time, it's important to understand them. We have a history of demonstrating that. For instance, ten years ago, we weren't discussing Wi-Fi or power on the aircraft, and there was a time when we didn't even have a loyalty program at Southwest Airlines. As consumer demands and expectations evolve, along with different generations of flyers entering the system, we will continuously assess that and understand what our customers want. If that indicates a need for change, we will evaluate it and make the right decision. We have a proven track record in this area concerning our product and customer experience. This does not imply any prediction regarding premium offerings in the cabin; I just want to emphasize that we are receptive to changes in demands, and we will respond if necessary.

Bob and Ryan, I appreciate that. And then maybe if I can just get a quick follow-up for Tammy. Any ability to tell us where you view your weighted cost of capital today?

Yes, sure. It's probably in the high 8s, close to between 8% and 9%. We estimate it to be around 8.6% to 8.7%.

Okay. Appreciate that, Tammy.

The next question is from Helane Becker with TD Cowen. Please go ahead.

Thanks very much, operator. Hi everybody. Thank you for the time. As I look at your numbers for the fourth quarter, your revenues were up at 12.5% or something, and your costs were up 10.5%, and yet you weren't able to see significant margin improvement because of the things you already talked about where you have inflationary pressure. But as we look forward to the next one year, how should we think about the seasonality of your business now? Because it seems like you said everything was great for the fourth quarter, and yet you didn't perform significantly better than you did last year, and I would have thought that last year, given all the issues, you would have performed a lot better. So maybe you can help me bridge beyond just the obvious labor cost inflation and other inflationary pressures, how you get back to those margins you used to report? And then do you expect any book away from the flight attendant asking for a strike vote?

Yes. Maybe Helane, thank you. Maybe I can start and...

That was a lot of questions.

Yes, I'll do my best to recall everything. Generally speaking, the most significant impact in the fourth quarter was our decision to quickly restore capacity. This choice meant getting our aircraft back to normal utilization and ensuring that all our planes and pilots were operating. Consequently, our ramp-up in capacity was beyond normal, which resulted in a decrease in load factor. I believe this was the primary factor contributing to our performance being different than usual. Our plan for 2024 is obviously to normalize in that area as we adjust our capacity. So, to me, that is the main point. I don't link this to any holiday-related booking issues, such as those related to Elliot. The focus really was on how quickly we restored capacity. Reviewing customer behaviors and metrics for demand at Southwest Airlines, there is no sign of any negative carryover or booking issues. In fact, the holiday periods were the strongest of the quarter. Regarding the flight attendant matter, I am very proud of our labor team. We ratified nine agreements in just over a year, with two remaining, one being with TW 556 representing our flight attendants. We're currently in federal mediation, where the mediator sets the dates and meeting times, and we are eager to finalize a contract. Similar to our pilots who are also in mediation, I am optimistic about reaching an agreement. The strike authorization vote does not indicate we are heading toward a strike, as many steps must occur before reaching that point. Therefore, I am not concerned about a strike in light of the authorization vote. When our pilots had their strike authorization vote, we did not observe any significant customer concern or awareness regarding it. Thus, I do not anticipate any negative impact on customer demand due to the flight attendant vote.

No, there's no evidence in anything that we track from a customer sentiment perspective that would make us concerned about that.

That sentiment is fully recovered to at this point. And our NPS scores, our customer satisfaction have recently have been records and certainly back to pre-pandemic levels.

Okay. That’s really helpful. Thank you.

We have time for one more question. We'll take that last question from Dan McKenzie with Seaport Global. Please go ahead.

Thank you for including me. Regarding efficiency and the potential for further improvement in 2025, what prior year could serve as a useful benchmark for investors looking to understand future FTEs per aircraft? Additionally, is it reasonable to expect that Southwest could fully achieve this by 2025?

Yes, I'll answer directly and add Andrew, if you want to chime in. I think we're not ready to talk about that in maybe as much detail as you want until we get to our Investor Day here later this year. But absolutely, it's just like the goal of covering our cost of capital this year, and getting back to our historic returns and ROIC well above WACC, restoring efficiency is right alongside in terms of the key goal or a key goal. We ramped up our hiring quickly to be able to restore the network and get all of our aircraft flying. That hiring peaked in October to November, and we have been decelerating that rapidly here in the last 60 days. The plan is to, again, to grow six-or-so percent this year and then to end this year with the same or fewer heads than we began the year, which will obviously help our efficiency quite a bit. Not ready to discuss 2025, but we would have certainly a directionally similar goal in 2025. We also have a significant number to hate to tease here. We have a significant number of efficiency initiatives that we are planning around both efficiency of the aircraft and efficiency of our people and processes as we think about things like the turn, and we'll be sharing a lot more about that again in our Investor Day later this year.

One aspect to note is that the same cross-functional teams we use to expedite our hiring are now focused on enhancing our efficiencies. This team is engaged weekly to meet our targets concerning headcount distribution by year-end. While we are aware of the full-time equivalent per aircraft, we are also managing a variable called CASM, as the way we operate our aircraft can differ. For instance, having two flights a day requires different ground staff compared to six flights a day. Consequently, pilot pay and block hours may vary based on how we schedule our flights. Thus, the final CASM for our aircraft is influenced by our operational strategy and staff allocation. While FTE per aircraft is a valuable metric, it is challenging to compare across airlines due to outsourcing variations, and it may send misleading signals. Our focus will be on optimizing labor CASM effectively.

Very good. And if I could just squeeze 1 last 1 in here. It's a question on the shift to the cloud. How much of Southwest has shifted to the cloud at this point? And once you complete that endeavor, what could the savings ultimately look like, once that transition is completed? Is it tens of millions, hundreds of millions? And is that an opportunity?

You're pushing my technical limits here, but like many companies, we are working on a strategy to transition to the cloud. However, it's important to selectively choose what to move. It's not as straightforward as it may seem. I estimate we've shifted just under 50% so far, and we aim to increase that significantly. While there are certainly cost savings involved, I view them as more modest. The primary benefits are improved reliability and the ability to maintain operations, which is crucial for an airline. We can't afford to have systems down for even 30 minutes. So, much of our cloud transition is about enhancing resilience and modernizing our code base, in addition to achieving cost savings. You will see some cost reductions, but I anticipate they will be in the tens of millions rather than hundreds of millions.

I think, Bob, we have made significant progress on the fraction side. However, when discussing it internally, our focus is less on the costs associated with using a larger hosted system and more on breaking it down into microservices in the cloud. This approach enhances productivity and allows us to refresh and improve applications over time. Ultimately, the real advantage lies in the speed to market for new products and the support for existing ones. Therefore, the benefits are felt elsewhere in the business rather than from hosted costs alone.

The other aspect to consider is that there is a significant cost associated with being down and experiencing issues, both in terms of revenue and expenses. For example, previous incidents like the NOTAM outage significantly impacted the industry. Thus, minimizing issues—whether that means reducing their frequency, shortening their duration, or eliminating them entirely—will likely result in greater cost savings than even technological advancements. Reducing irregular operations is incredibly effective in this regard.

Very good. Thanks so much for the time, guys.

Dan, thank you.

Okay. That completes the analyst portion of our call. A quick reminder that the transcript and a replay of the call will be available on our Investor Relations' website. I appreciate everyone joining, and have a great day.

Ladies and gentlemen, we will now begin with our media portion of today's call. I'd like to first introduce Ms. Whitney Eichinger, Chief Communications Officer.

Thanks, Gary. I'd like to welcome members of the media to our call today. Before we begin taking questions, Gary, could you please give instructions on how everyone should queue up for a question?

Our first question comes from Alison Sider with The Wall Street Journal.

Hi, thanks so much. I just wanted to see what you made of a center of Duckworth today calling on the FAA to deny the waiver Boeing of Sox to MAX 7. Is that anti-ice issue, do you think that something Boeing should have to address before they can start delivering those planes?

I'll start, and Andrew, you'll fill in, Ali. Obviously, the certification of the MAX 7 and the issue there, that's really Boeing. I don't want to speak for Boeing or get ahead here. Obviously, we want the MAX 7, and we want it on the best timing possible. So I don't want to talk for Boeing, but it is one more thing to consider here in the certification process and certification timeline.

I would say that the certification is a technical process between the FAA and Boeing. And I think they've been doing a good job. It's been slower than we would like, but it's been technically based and it's off a public comment. So it's an opportunity for people to comment on that for technical analysis to be done. And so we're not a party to that. We want the aircraft. It's a question of when we'll get it, not if we'll get it. So we're pleased that they're taking their time to make sure it's safe, and we support whatever way the FA wants to go.

And I mean do you have any plans to increase your own oversight of Southwest Plans on the Boeing production line?

We have already taken action on that. In late 2022, we adjusted our approach. For a long time, we had representatives at the factory, but we expanded this to a team of AMP licensed mechanics responsible for overseeing our aircraft during production. Boeing has quality personnel on their payroll, and they follow our direction. They inspect specific areas in the factory, which we designate, during the assembly process that typically takes a few days from wing construction to the aircraft rolling out. There are about 80 areas where we have established requirements. Both their personnel and ours carry out inspections, and several times each year, our quality assurance team visits to examine our inspectors to ensure everything is functioning properly. This provides strong oversight during production. Once the aircraft leaves the factory, it goes through a customary acceptance inspection overseen by the FAA, which grants a final certificate of airworthiness. It then integrates into our operations specifications, and our maintenance program is quite comprehensive. As the largest operator of the 737, we have gathered extensive data, and our ongoing analysis and safety surveillance system enable us to fully understand the aircraft's performance and ensure it meets all expectations.

Thanks.

The next question is from Leslie Josephs with CNBC. Please go ahead.

Hi. I was wondering if you have any thoughts about how a Chapter 7 of an airline in the United States would affect the industry? Are there jobs for those employees should that happen? And then do you think that the Justice Department would ever let you buy another airline?

Hey, Leslie, it's Bob. There's a lot happening in the industry right now with potential mergers and acquisitions, as well as issues with aircraft deliveries and the geared turbofan. In my 36 years in the industry, I've never seen so many moving parts. One thing that remains constant is our commitment to our business. We are focused on enhancing Southwest Airlines, striving to be the best carrier possible, and improving our returns and profit margins, as we've discussed. It's difficult to predict what might happen, but historically, when opportunities arise for Southwest that make sense, we evaluate them. However, I don't want to speculate about anything happening in the industry or regarding other carriers.

I think with the benefit for Southwest Airlines, Bob, is that we have a plan, and we control our destiny. We hit our plan, we get our returns where we need to be. We don't need something to break our way to judge or anything else or rule anything. Our plan delivers our results.

Our next question comes from Rajesh Singh with Reuters. Please go ahead.

Hi, Andrew, do you have any update on the time line for certification of MAX 7? Earlier, it was expected by April. So do you see any risk of the certification process getting slowed down due to the current events with Boeing?

We receive weekly updates on the certification process, so we're aware of what has been submitted and what hasn't. However, the FAA is responsible for overseeing and inspecting the process and making the final decisions. Previously, we had planned and anticipated certification by April, followed by some operational specifications work that could extend into the end of the year, which would mean a flat outcome until next year. This was just our latest assumption, and we have had various assumptions throughout this process. As Tammy mentioned, we will adjust our plan based on new information. By taking a conservative approach and allowing ourselves some lead time, we aim to ensure that short-term fluctuations do not impact our plans for this year.

And Bob, I have a question for you. Do you have confidence in Boeing's currently sit to address place who's facing the company?

Hey, Rajesh, Boeing has been a partner with us for 52 years. And I have absolute confidence that between the FAA oversight work that's going on, the work that Boeing is doing that Boeing will, working with the FAA, will address the quality issues and we'll obviously come out of this a better company. I've talked personally to their leadership. They're committed to doing anything and everything it takes to be better and to address the problems. And as I said before, a better Boeing is very good for Southwest Airlines. So yeah, I have absolute confidence that they will work their way through this and address the issues.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Ms. Eichinger for any closing remarks.

Thanks, Gary. The news release and our contact information are available at swamedia.com. We thank everyone for joining.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.